OGJ Washington Editor
WASHINGTON, DC, Feb. 10 -- US oil and gas producers would not be able to compete successfully against their foreign counterparts if long-standing rules covering taxes on foreign income are changed, a new study by Wood Mackenzie found.
The study, which the American Petroleum Institute commissioned, said US producers would face potentially lower returns from foreign operations, would bid on fewer projects, and would successfully bid less often if Obama administration foreign tax credit modification proposals are adopted.
“Revising the rules in this way would surely hurt US companies and US workers,” Stephen Comstock, API tax policy manager, told reporters at a Feb. 8 briefing. “If US-based companies are forced to withdraw from an oil and gas development abroad because a new law instantly turns it uneconomic, that affects jobs at home and it potentially reduces revenues. I agree that this provision would raise money, but not because it closes some loophole or fixes some existing problem. It merely subjects our companies to double taxation.”
Current federal regulations make US companies subject to foreign taxes on their worldwide income. To prevent double taxation, US companies’ income taxes paid to foreign governments may be used to offset US taxes on that income. A US taxpayer must show that this paid foreign tax is an income tax, as defined under Section 901 of the federal Internal Revenue Code, to claim this offset.
Oil and gas producers with foreign operations are often categorized as dual capacity taxpayers because they also make royalty and other nontax payments to foreign governments. To claim the foreign tax offset, they must show that the foreign income tax paid is not a payment for another type of specific benefit.
Obama administration proposals to change the dual capacity rules would subject US producers an additional or residual US tax burden, WoodMac’s study said. In countries where oil and gas income is taxed at a higher rate than general business income, the proposed changes would treat US companies’ foreign oil and gas income as if it was taxed at the lower rate, reducing the allowable offset. The difference would be classified as an operating expense and therefore not creditable for US tax purposes.
Reduced value, returns
The additional US tax would reduce overseas’ projects aftertax value and returns for US producers in 14 overseas countries, potentially making them less able to acquire or develop overseas assets economically compared to competitors who do not face such a burden, according to the study. “As a result, non-US based investors would obtain a competitive advantage over the US based investors in the race to acquire new reserves and grow,” it said. “This competitive advantage could result in a reduction in global reserves available to US investors because a non-US investor would be able to earn a higher internal rate of return on these investments relative to US investors. Non-US investors could outbid US investors for new reserves [while] still generating adequate economic returns.”
The change would put US companies at a disadvantage not only to foreign competitors operating in their home country, but also to competitors from countries where taxes are calculated under a territorial system where income generated overseas is generally not subject to the a company’s home country taxes, WoodMac said. “The result is that of a reduction, sometimes significant, in the returns and value of moving from an in-country system to [a] new US system,” it added.
Adopting the proposed change, for example, would increase net present values of home competitors in foreign countries over US firms by 73% in Great Britain, 85% in Australia, and 110% in Qatar, it said. The higher invested rates of return non-US investors would enjoy would be as high as 80.1% in Iraq, 38.7% in Trinidad and Tobago, and 31.9% in Norway under a new US system, the study found.
The analysis was the final of three studies on federal oil and gas tax proposals API asked WoodMac to conduct. The two previous studies examined the effects of repealing intangible drilling cost expensing and the domestic production activities deduction, and the difference in federal revenue generated from raising oil and gas taxes and from allowing development and production of more federally controlled oil and gas resources.
The proposed dual capacity tax change was not part of the oil and gas industry tax preferences the White House proposed repealing in its proposed fiscal 2010 and 2011 budgets. President Obama, in his Jan. 25 State of the Union address, called on Congress to remove the provisions, which deal with percentage depletion, intangible drilling costs, and other tax incentives and application of the Section 199 manufacturers tax credit to the oil and gas industry, once the White House submits its fiscal 2012 budget request on Feb. 14.
API officials nevertheless expect a proposal to modify the foreign tax credit’s dual capacity definition and raise about $4 billion of revenue to be made elsewhere in the administration’s proposed 2012 budget. “The US oil and gas industry pays a substantial amount of taxes abroad,” said Comstock. “Being able to credit those payments to offset the US tax on that income is important to our members. We’ll need to be vigilant.” The petroleum trade association expects the White House to repropose the $36.5 billion of oil tax preference repeals it submitted a year ago, he continued. “We’re also concerned about new proposals [that] were made in some 2010 legislation,” he added.
Marty Durbin, API’s executive vice-president of government affairs, said the petroleum trade association was encouraged by Obama’s outreach to the general business community and his regulatory review order. “But we’re not happy with what he said in his State of the Union address. I found the suggestion that oil and gas are yesterday’s energy insulting, considering how much this industry spends on research and development of new technologies in a variety of areas,” he said.
He said that when Obama talks about stimulating the general economy and creating new jobs, the oil and gas industry is “the low-hanging fruit” with the 9.2 million of jobs it already has created and the speed with which it could create more if it was able to explore, develop, and produce more federally controlled domestic areas. “There may be some people who are interested in vilifying the industry,” Durbin said. “We don’t want to pick a fight with anybody. We want to work and find solutions. The focus should be on what we all can do together.”
The election of more Republicans to Congress this past November, combined with surveys that have found the general public opposing new oil and gas taxes by 2-to-1, suggest that policymakers and voters won’t support another White House call to repeal preferences in the 2012 budget, he indicated. Simplifying the federal tax code, as Obama proposed in his State of the Union address, will take more time, both API officials said.
“We’re still trying to figure out where we stand on general tax reform,” Comstock said. “There are still concerns among several of our members about how capital costs would be recovered. Our companies are still trying to work this through.” API would be willing to discuss having the US adopt a territorial approach to taxing US companies’ foreign income, “but the devil would be in the details,” he continued. “There would have to be extended and substantial discussions to make such a radical change.”
Contact Nick Snow at email@example.com.